Tax Insurance: Using insurance to remove potential tax exposures

Increased competition between insurers (four main tax markets in 2016, now 10+ credible markets) together with increased understanding of and demand for specific tax insurance products in both transactional and operational scenarios, has led to tax insurance becoming a commonly used tool for mitigating tax risks arising in a wide range of circumstances, most commonly those identified in M&A transactions.

HWF are able to structure insurance backed solutions to ring-fence potential tax issues providing certainty if that issues crystallises.

When can tax insurance be advantageous?
  • Low risk & high quantum and certain medium/higher risk tax issues identified as part of the M&A due diligence process that are likely to be excluded from any W&I policy.
  • Protection against operational tax risks (e.g. VAT, transfer pricing, tax residency etc).
  • Insuring non M&A transactional tax risks (e.g. arising due to reorganisations, refinancings etc).
  • In a pre-sale or carve-out context, ensuring that known risks are covered prior to a sale process in order to minimise due diligence issues.
  • For private equity, protection against fund level risks (e.g. permanent establishment, taxation of management LLP level income etc).
Tax insurance for operational tax risks
  • With tax authorities taking a more robust approach, businesses increasingly need to maintain a cautious approach to their tax affairs.
  • Where a business has concerns over its current or historical tax treatment it can look to offset this risk with tax insurance.
  • Alternatively, it may be the case that a business has a balance sheet provision for a particular tax issue and tax insurance can also be used to give certainty allowing the release of capital.
Tax insurance for M&A transactions
  • Quantification and likelihood of crystallisation of a potential tax risk identified in a M&A transaction is often a key negotiation point between the buyer and seller.
  • Such tax risks can be dealt with by way of indemnity or price chip/escrow but this will have a negative impact on the seller.
  • Occasionally, tax issues with a significant perceived quantum can stall the transaction’s progress.
    Tax insurance can be a cost effective and commercial way of dealing with these potential uncertainties.
Developments in tax risk insurance
  • Historically, only legal interpretation tax risks could be insured.
  • North American and Western European jurisdictions.
  • More recently, more “factual” tax risks (e.g. valuation risks, substance risks, etc) have been insured.
  • Geographical focus widened to most of Europe, North America and Australasia, and parts of Asia and South America.
  • Typically disclosable schemes and more aggressive tax planning are not insurable.
Pricing of specific tax insurance:
  • Premium rate is based on the limit required for the policy.
  • Limit includes the potential tax exposure, interest, penalties, defence costs and tax gross-up (if necessary).
  • Typical range of premium rate is between 1% and 7% (subject to minimum premium).
  • IPT based on the rate in the jurisdiction of the insured entity.
  • Excess normally small and in relation to defence costs only.
Key Points:
  • Policy can directly insure a tax issue or sit behind a contractual indemnity.
  • The costs associated with defending any tax authority challenge are often covered.
  • Policy term typically matches the statute of limitations in the relevant jurisdiction (typically 7 years).
  • Policy will either insure the whole liability or provide cover in excess of the probable outcome.
  • Policy will exclude fraud of the insured party including wilful concealment of key information from insurers.
  • Insurer may require small fee for engaging their advisers.